The mercenary qualities of liberal economists

Here is Mankiw circa 2007:

Thursday, July 19, 2007

The Taxation of Carried Interest

Several people have asked me my views on the taxation of carried interest. It is a complicated issue, and I don’t pretend to be an expert on tax law, but here goes.

Deferred compensation, even risky compensation, is still compensation, and it should be taxed as such. Paul Krugman hit the nail on the head with this question:

why does Henry Kravis pay a lower tax rate on his management fees than I pay on my book royalties?

The analogy is a good one. In both cases, a person (investment manager, author) is putting in effort today for a risky return at some point in the future. The tax treatment should be the same in the two cases.

One hedge fund manager told me that the initial value of the carried interest should be taxed as ordinary income and then the subsequent returns should be taxed at the capital gains rate. Maybe so, but taxing the terminal value as ordinary income (as is being proposed) seems strictly better for the manager in present value. It is as if the manager put the initial value of the carried interest in a tax-deductible IRA, deferring tax on this compensation until the money is withdrawn at a later date. The proposed reform, therefore, does not seem excessive.

John Berry’s recent article on carried interest suggests that the Bush administration is opposed to reform. If so, I fear the administration is on the wrong side of the issue.

Update: The FT reaches the same conclusion.

Here is Mankiw Circa 2012 after a series of lengthy contortions:

Capital Gains, Ordinary Income and Shades of Gray

Critics of current law think it is unfair that these private equity partners are taxed at capital gains rates, whereas other high-income individuals like doctors and lawyers pay the much higher tax rates for ordinary income. It is a reasonable point, and some reform may well be appropriate. But as the tax situations of Abe through Earl illustrate, it is not obvious what the best approach would be. Not all problems have easy answers.

How to resolve the puzzle? As per Wiki

From 2003 to 2005, Mankiw was one of President George W. Bush‘s top economic advisers, and was chairman of the national Council of Economic Advisers (CEA). In November 2006, Mankiw became an official economic adviser to then-Massachusetts governor Mitt Romney‘s political action committee, Commonwealth PAC.[15] In 2007, he signed on as an economic adviser to Romney’s presidential campaign.[16]

Mitt Romney on capital gains and carried interest:

So Mitt needed obfuscation and it appears Mankiw delivered.

Now, ask me if I am shocked or outraged?  Nope, not in the least.  Economics is after all a social science.

HT Econospeak

Laughed out of the Laffer curve

In class today I presented a seminar on, among other things, the uses and abuses of the Laffer curve. Why it is not called the Laffer bell curve I have no idea; it is always drawn like one. The students were kosher at the extremes: a tax rate of 100% was likely to lead to near zero income tax for the state; similarly they totally grasped as would anyone that a 0 % tax rate times anything was zero. But then the chuckles started.

I suspect it would be a stronger argument if the Laffer curve was bell shaped but at the summit it was flat over say a range of at least twenty percent. The students simply would not buy that a reduction from say 60% on the income of the supper rich to 40 % would not only yield the same but greater tax revenues for the state. And it did not matter how many ad hoc conjectures I threw in: increase in hours worked from the supper rich and the increase in support staff that implied and thus the increase in national output and thus a larger economic pie to tax.

It was more than just that they did not believe that people worked that way it is that they immediately understood it as trojan horse for the rich to decrease their marginal tax rates. 30% of 10 million is still 3 million who would not take that? But I had to explain for the super rich the labour market really is a choice between leisure and income. And when you are super rich you just might ask yourself do I really need another million dollars?

But then there were the questions about the augmentation of state revenues through a reduction in the top marginal rates. And I said I only know of one: Russia. To which we all had to laugh.

The Euro: A perfect case study in political economy: Krugman vs the other Gordon

One of the problems with economics is that it tends to narrowly parse its objects of inquiry. That is, it suffers from a deranged elegance: too few factors are considered and the ones that are get so rendered that they rarely resemble the original beast. It is curios in this respect that Paul Krugman should play the church mouse and Stephen Gordon the Scrooge. But hey I come from an Anabaptist tradition so what do I know. Between simply getting for free through a culture of potential heresies in the margins and a culture of perfecting the reformed holy writ something almost always creeps in.

Shit happens and in this, the Euro, Gordon is closer to the mark than Krugman.

As Gordon (Stephen not to be confused with the other venerable Gordons: different breed I gather) argues:

The euro project had much more to do with advancing the goal of promoting an ever-close political union than implementing a sensible monetary policy. As the current crisis has shown, a common currency is hard to sustain without a central government that is able to redistribute income from one region to the other. It seems to me as though the people who pushed the common currency hoped that by the time the euro was put under pressure, the central government with the necessary powers of redistribution would be in place.

I think Mr. Gordon is on to something but he does not go far enough. Both right and left in Europe feared the Euro was part of a broader project of cajoling EU countries towards a more neo-liberal policy paradigm (perhaps one which Gordon would support). The point was to force an independence between the central banks and potential or actual “political” interference (again something Gordon would probably support). Note that in Sweden the fight over the adoption of the Euro played itself out in somewhat this way. Interestingly, both the social democrats and the “bourgeois” parties wanted the Euro. The popular left did not because despite the functional independence of the SCB the popular left wanted the possibility of a bank that could be capable (if forced) of taking everything from exchange to inflation rates into consideration.

The other side of the Euro debate was the desire to make sure that the EU was not plagued by beggar-thy-neighbour monetary policy–reasonably understanding that a race to the bottom could be negative sum. And I think this is why the putative left establishment in Europe supported and continue to support the Euro.

Krugman is thus naive; the Euro was never a mere technocratic exercise designed to reduce transaction costs. Yet Gordon is equally naive for different reasons. The Euro was only in part about transaction costs and only in part about redistribution (although as Gordon notes redistribution is the spoonful of sugar that was supposed to make the medicine go down) it was also in large measure a plan to take the perceived candy jar away from the children–politically accountable national central banks.

In this regard Canadian central banking works because politically speaking it is free to rest just above whatever the FED decides. Thus this why the BOC never goes offside: it takes its cues and dues from the FED not parliament. The EC could not guarantee this unless all were brought to heel: thus the Euro.

If we had a less independent central bank in Canada I suspect Gordon would be singing a different tune.

The Ignoble and Noble Prizes for Economics

For Immediate Release

The Real-World Economics Review Blog is holding polls to determine the awarding of two prizes:

The Ignoble Prize for Economics , to be awarded to the three economists who contributed most to enabling the Global Financial Collapse (GFC), and
The Noble Prize for Economics , to be awarded to the three economists who first and most cogently warned of the coming calamity.

It is accepted fact that the economics profession through its teachings, pronouncements and policy recommendations facilitated the GFC. We also know that danger signs became visible long before the event and that some economists (those with their eyes on the real-world) gave public warnings which if acted upon would have averted the human disaster.

With other learned professions entrusted with public confidence, such as medicine and engineering, it is inconceivable that their professional bodies would not at the very least censure members who had successfully persuaded governments and public opinion to ignore elementary safety measures, so causing epidemics and widespread building collapses.

To date, however, the world’s major economics associations have declined to censure the major facilitators of the GFC or even to publicly identify them. This silence, this indifference to causing human suffering, constitutes grave moral failure. It also gives license to economists to continue to indulge in axiom-happy behaviour. Nor has the economics establishment offered recognition to those economists who were not taken in by fads and fashion and whose competence, if listened to, would have prevented the collapse.

These two silences reveal a continuing moral crisis within the economics profession . The Ignoble and Noble Prizes for Economics are being offered as small first steps towards a cure.

Poll Procedures for the Ignoble Prize for Economics

Stage One: Nominations and Evidence

Nominations for both prizes are open to the international community of economists, rather than limited to a closed and secret shop. For each nominated economist an evidence page will be opened on to which people can leave evidential comments. In this way a documented case for (and against) each candidate will be built up.

I don’t know maybe we should have a prize for ignoble ideas. Efficient markets and rational expectations were pretty much baked into the reform and conservative wings of the profession. To single out Fama or Friedman seems odd. What about Krugman? He has authored how many papers with rational expectations sitting TDC? Progressive liberal economists need to take some blame for having played and purged along to get along. Economists, for the majority, were a pretty cozzy lot before the GFC. I am glad that after the GFC (and for one a faux noble) that some decided to break ranks ATF, but they enabled the general ideological climate as much as any putatively right-wing protagonist of the profession.

Selected Central Government Debt Ratios: An image begs a thousand questions

When discussing with my undergrad students why I thought Japan Inc. was bust I trotted out the graph below.  However, this morning while looking at the graph several questions came to mind.

1) From 1998 – 2008 what was average real interest rate in Japan and how does that compare to the ten years previous to 1998?

2) What has been the average level of inflation in Japan since 1998?  Again how does that compare to the 10 years previous to 1998?

I already know the answer to those questions but I would have not arrived there by any HAT (highly accepted theory).

3) Why are we even talking about programs cuts in Canada before it is clear that the world economy and the US economy has started a robust recovery? And why especially when Canada is way below the advanced capitalist curve (in terms of debt to GDP)?

Click for larger image

Styalised facts being what they are: CD Howe, the Fraser and CCPA

Some things just pass as fact when further scrutiny turns things around a bit…or at least requires a couple of qualifications. When I see words like *always* and *never* my bullshit sensor goes off the scale.  As for example in this passage from the good cop bad cop of Canadian economics blogs:

One can predict with a remarkable degree of precision the conclusions of such think-tanks as the Fraser Institute (‘markets always work’) or the Canadian Centre for Policy Alternatives (‘markets never work’). With the notable – and laudable – exception of the work of the CD Howe Institute (disclaimer: I have nothing to do with the CD Howe Institute)…

I will grant this much, the Fraser has never made an argument that I am aware of that argues for more, bigger, etc.,  government (although I stand to be corrected can one of readers find some contradictory evidence).  Does such a claim stick to the CCPA?  Last time I checked, the CCPA was in favour of *market based* approaches to climate change.  Not only that they have shown interest in a VAT tax progressive income tax trade-off.

So what gives here?  I dunno perhaps just misplaced centre of the road “ho hum we are the only ones who are balanced around here.”  Yet my suspicions get narrowed when I focus in on the statement:  “(disclaimer: I have nothing to do with the CD Howe Institute) .”  There is that absolute *nothing*.  Hard sell brother.  Word of advice: leave the absolutes for God.  However, the point is, your blogging comrade in arms, and arguably the majority contributor to said blog’s traffic going by comments (110-8 is hard to deny), is an economist affiliated with the the CD Howe.  I link him not because I think I have uncovered some mysterious conspiracy.  Your CD how affiliated economist has been quite open about this. Why, indeed, hide it?   Ah schucks *nothing*.  Forgive me, but your blog is not sub-titled “where I square off against the left, middle and right of the public debate on economic policy, but leave 75% of the floor to the CD Howe.”

But where is the evidence that the CD Howe is balanced: as in neither for or against markets (to stay with a worthless solipsism)?  Some young beaver should do a little qualitative research and see just how many times the CD Howe has come out in favour of more market based solutions rather than less.  If I had to wager I would put at somewhere around 20-25% gov and the rest to the putative markets.  But your unflinching belief that 25 (gov)-75 is the 50-50 scientific balance betrays more than nothing and less than everything.

We do not do spin…We don’t lose our focus: Carney the rain maker

Listening to Mark Carney talk tough is like watching Stephane Dion pound his fists on the table.  Well ok a little more credible than that.  Being a former GS man you know he knows people who know people.  Some of which I should think are quite unpleasant characters.  Problem is there is not really a robust connection between the value of the Canadian dollar and inflation or deflation.  Currency traders probably know this…at least more than they have some version of the standard (and empirically dubious) model in their head.  So when Carney says “we take our inflation target seriously.”   Currency traders likely shrug and say: “we are banking on it.”

Mr. Carney said he has a range of tools and he can use to dampen the blow of the currency’s rise, and signaled that any investor who thinks he’s shy to use them is making a mistake.

“Markets should take seriously our determination to set policy to achieve the inflation target,” Mr. Carney said. “Markets sometimes lose their focus. We don’t lose our focus.”

Carney’s problem (well actually the manufacturing sector’s problem) is that the BOC does not care about the level of activity in exports. It only cares about their target.  Full stop.  So unless deflation increases in some way that can be definitively linked to the appreciation of the CAD–which is doubtful–the BOC is not going to do anything.

Are currency traders and Bank economists dumb as a sack of hammers?

The short answer is no despite what has been argued here and here.  Bank economists may be a comfortable and no doubt arrogant bunch (imagine combining the natural arrogance of economists with the comfy smugness of Canadian bankers… thankfully a cocktail party I will never be invited to).  But do we really believe they do not understand the difference between raising and lowering the value of a currency and the different mechanisms required for each?  I think they probably do.

So does Erin Weir over at the Progressive Economics Forum.  He makes a cogent case why bank economists may be arguing (erroneously) that the BOC does not have the resources to intervene in fx markets to depreciate the CDN dollar.  In a nut-shell Erin argues that the CDN banks are looking to do a little foreign financial asset shopping and that a high CDN dollar makes that prospect even more lucrative.  I like this explanation because it does not rely on bank economists being stupid, but, rather, hard-working employees serving their employers to the best of their abilities.  And I if that requires misdirection so be it.  Let me put it this way: I think they are bank employees before they are economists.

When it comes to economists and bankers I always prefer rational actor models.  But hey ad hoc explanations are always amusing. And insinuating that people are stupid does allow one to feel superior I suppose.

Next comes currency traders.  Are they as dumb as a sack of hammers?  Again I think not.  Aggressive if jittery risk takers…you bet…stupid nope.  They have played this game before and it is called chicken.  I bet they do not think the BOC has the nerve to go into the fx markets in big way, that the BOC does not want the precedent; that it does not want to fuel the notion that the value of the CDN should be set be fiat etc., etc.

Sure, yesterday the loonie lost two cents on Marky Marc’s: “I really mean it this time, I just might do something.”

Today it was back up a cent by noon trading.


The game of chicken is on.

Forget the Bank of Canada: We need an INVITE program to stem appreciation of the CDN Dollar.

If what we are worried about is an overvalued CDN dollar which is caused by speculative flows then why the focus on the Bank of Canada?  Exchange rates are not really in the BOC’s mandate.  Sure in the case where an appreciating CDN dollar is causing further deflationary pressures it could be argued that exchange rates are within the purview of the Bank’s mandate.

But the BOC is a conservative (in both the ideological and cultural sense) institution.  Canada does not face the same structural dynamics (problems) as the UK and the US.  And thus I doubt arguments for non-conventional monetary policy responses are going to get very far with the Bank.  Moreover there are downside risks to pursuing unconventional monetary policy.  We might get a lower exchange rate at the expense of perverse side-effects.  So forget the BOC; leave them out altogether.

Thankfully, however, when it comes to exchange rates there are policies available to the government. On such policy could be called an  Investment Inflow Tax Equilibration  program (INVITE).  It would work like this.  A simple 2% tax on all inward portfolio investment (as Brazil just announced) would help stop appreciation in its trax.  Second if we really think much of the dollar’s appreciation is being driven by gas and oil then an additional 2% tax on all oil and gas investment inflows regardless of the type (portfolio or direct) would help further dampen the speculative plays in that sector.  The terminator seed on the INVITE program would be when Canada’s manufacturing sector returned to some degree of health.

The False Dichotomy: Minimum Wages Vs WITB

As designed, the WITB (Canada’s version of the US earned income tax benefit) is not structured to increase the minimum annual full time wage.  In most provincial jurisdictions the WITB kicks out just before or just after the minimum annual full time wage is achieved.

For example a single person earning minimum wage working full time of 35 hours a week in Quebec will have an annual gross income of between 14,000 and 15,000.  The WITB for the lower amount is 230$ for the year or 19.16 per month.  The WITB for the higher amount is 30$ a year or 2.50$ per month!

As is clear from the example above the WITB is designed to phase out at the point a full time minimum wage salary is achieved.  The whole point of the program is to make sure that there are not any tax penalties for working.   And it most definitely is not about augmenting the full time minimum wage.

So in sense those that argue in favour of the WITB over the minimum wage as a poverty alleviation strategy simply do not know what they are talking about because full time minimum wages are being used by the government to set the income threshold for the program.  That is, the only way in which WITB can be viewed as augmenting the minimum annual wage is if an individual works less than full time then the WITB kicks to augment the wage but outside of a narrow band not to the full time minimum wage level.

In the illustration above the WITB would contribute 230$ to someone working just shy of 35 hours a week 52 weeks a year. However, for someone working part time at minimum wages in Quebec, the WITB would kick in around 750$ a year effectively increasing the minimum wage by .78 cents an hour.

Hence it is only in the case of a part-time minimum wage worker that the WITB makes a meaningful adjustment to the minimum hourly wage.  However, in the last example provided above, someone working 20 hours a week at min wage including the WITB will have an annual income 8,640$.

Hardly a poverty arrestor.

Interestingly one of the perverse outcomes of the program is that there is a built in incentive for min wage employers to offer less than full time hours because the further away from full time the higher the level of the wage subsidy/premium.  The other perverse outcome (some will say a feature because it targets the worst of the worst off–part time min wage workers) is that unlike increases in the min wage which increase all min wage workers’ salaries the WITB only meaningfully increases part time min wages while doing little to nothing for full time min wage workers.